Your Next Great Stock: How to Screen the Market for Tomorrow's Top Performers

Chapter 20. The Accrual to Be Kind Screen

My barber doesn't need an accountant to figure out how much money he makes. He uses something called cigar box accounting. It requires nothing more than an empty cigar box and the ability to count. The cigar box is optional.

The money he collects for each haircut ($10 plus tip) goes into the box. Once in a while money for supplies—cans of talcum powder that look like they sold well in Hoover's day or the mysterious blue liquid the combs swim in—comes out of the box. At the end of each day, the money he has in the box, minus the few dollars he started with, is profit. Ask my barber how much he earned in a given day and he'll point to the box. Ask him how much free cash he generated, and he'll keep pointing.

Ask a publicly traded company how much it earned last quarter and how much free cash it generated, and you'll likely get two different answers. In what follows, I'll explain where the difference between those answers comes from, and how you can use it to do two important things. You can look through stocks you already own for signs of trouble. You can also search the entire market for stocks that look likely to produce plentiful returns.

Earnings aren't real. When a company says it earned $1 per share last quarter, it doesn't mean that it added that much to the cigar box. It might have added more or less. It might have added nothing. Suppose it added 70 cents. The difference between the $1 it earned and the 70 cents it has to show for those ...